Chapter 11 Bankruptcy Pros and Cons: 6 Trade-Offs Owners Weigh

Chapter 11 of the Bankruptcy Code generally provides commercial debtors with a process for restructuring their debt while continuing their business. In Chapter 11 bankruptcy, a business is reorganized and its operations maintained, but on the Bankruptcy Court’s terms. The big catch is that the process is often expensive and may take several years to resolve. If you’re considering Chapter 11 bankruptcy, you’ll have to decide if the pros outweigh the cons.

It allows businesses to restructure the repayment of their debts without erasing them completely. It’s a good option for businesses that can see a financially sound future ahead but are bogged down by debt loads that won’t let them reach it. Chapter 11 is often used by larger businesses to reorganize their capital structure. However, smaller businesses also find it useful, including to renegotiate leases and extend other debt payments.

Reorganizing your business in Chapter 11 bankruptcy comes with the benefit of an “automatic stay” that blocks many of your creditors from collecting on the debts you owe them. This stay is designed to give you some breathing room to reorganize. As a Chapter 11 debtor, you will usually continue managing the business’s assets. Businesses in Chapter 11 are subject to many reporting requirements. You must also make monthly reports.

Businesses often get stuck with leases that wind up being an albatross. Chapter 11 bankruptcy allows a debtor to ditch commercial leases with burdensome or unsupportable payment terms, but with an important limitation: The debtor generally has to make the decision on whether to keep or get rid of the lease within 120 days from the date the bankruptcy is filed. The court can extend the deadline by an additional 90 days on request. Tenants who file for Chapter 11 bankruptcy are often able to work out a deal when landlords see that the leases could be ditched.

Businesses tend to finance their operations with loans secured by their assets as collateral. In Chapter 11, a judge can look at the collateral and decide how much it’s worth right now, not how much the loan is for. Whatever the value of the collateral comes in at, that portion of the loan will stay secured. If the secured portion of the loan is less than the full loan value, the rest of the loan becomes unsecured and may be repaid at a significant discount.

Propose a Plan to the Bankruptcy Court

In a typical Chapter 11 bankruptcy, you will first propose a plan to the Bankruptcy Court that, after negotiations, is ultimately voted on by your creditors. A class of claims will be said to have accepted a plan when those who vote yes control two-thirds of the dollar value of the claims and more than half the number of the claims. Winning that vote may involve a great deal of negotiation, and you may find it difficult to persuade some or all of your creditors to agree to a debt repayment plan that has their best interests in mind while restructuring your debt in a manner that allows your business to thrive. Unsecured creditors may have an unsecured creditors committee appointed for them to keep an eye on things and protect their interests. When a Chapter 11 bankruptcy case is filed, the debtor has the exclusive right to file a reorganization plan for the first 120 days. After that initial 120-day exclusive period, other groups can propose competing plans.

If a class of creditors votes down your Chapter 11 plan, you may still be able to confirm the plan by “cram down” if the court decides the plan doesn’t unfairly discriminate against any class of creditors and is fair and equitable. Senior creditors have to be paid in full before the business’s owners can get anything under the plan.

The entire Chapter 11 bankruptcy process is often expensive and time-consuming, with many twists, turns, ups, downs, victories, and disappointments. Lawyers who specialize in Chapter 11 bankruptcy often charge significant fees for their services. By itself, the filing fee to kick off a Chapter 11 bankruptcy for a business is $1,167, with a separate $571 administrative fee on top. You must determine if the costs of the Chapter 11 bankruptcy and the time it will take are worth the potential for restructuring your company’s debt and creating a new beginning for your business.

Subchapter V

Fortunately, Congress created a faster and less expensive version of Chapter 11. Subchapter V of Chapter 11 of the Bankruptcy Code was created by a 2019 law called the Small Business Reorganization Act, which was designed to reduce costs, speed up the process, and require less paperwork compared with regular Chapter 11. Subchapter V is only available to small businesses with a limited amount of debt. To qualify, the business’s total secured and unsecured debts must be no more than $3,424,000. Over half of the debt must be from business activities. In Subchapter V, a trustee is appointed to help reach a consensual reorganization plan. There’s no requirement to pay quarterly U.S. Trustee fees. Because a Subchapter V proceeding under Chapter 11 does not require the appointment of a creditors’ committee, you may be able to confirm a reorganization plan with less expense and in less time.

Only the debtor business is allowed to propose a Subchapter V Chapter 11 plan, and only during the first 90 days. The court can confirm a Subchapter V plan where projected disposable income is devoted to making payments under the plan for three to five years. There’s no absolute rule that in every case equity owners must give up all ownership to the creditors before the plan can be confirmed. Although Subchapter V can be an attractive option for a business restructuring under Chapter 11, it’s not for everyone. Beyond the debt cap, timelines for a repayment plan may be shorter than under a regular Chapter 11 filing. Since Subchapter V is relatively new, it’s tough to predict how it will work in your case.

A Reorganization May Ultimately Fail

Despite your best efforts and the time, energy, and expense required in a Chapter 11 bankruptcy, a reorganization may ultimately fail. If this happens, your creditors can request the Bankruptcy Court to dismiss the Chapter 11 case or to convert it to a Chapter 7 case. In Chapter 7, your business will generally shut down and its assets sold off to pay as many of the creditors’ claims as possible. In Chapter 7 the business itself gets no discharge of debts, and the creditors can come after anyone who guaranteed payment.

Take the time to examine your business’s debts, its revenues, and possible future profitability, and consider whether a restructuring that involves reducing debt and lowering payments over time can get you from the ashes to a bright and solid future for your business. Despite the risks and complexities, Chapter 11 can be the best path forward for a financially struggling business to reorganize and go forward with new financing to create a path to success. Weighing the pros and cons of Chapter 11 bankruptcy will likely require a consultation with a bankruptcy attorney, and if you’re considering filing for Chapter 11, an experienced lawyer is a necessity.